Today I’d like to talk about “stepped-up” basis, which is an incredible benefit for people inheriting property, or other assets. Before I do, let’s just cover some basics regarding taxes on assets which are held for any length of time.
What do we mean when we say “asset?” An asset can include tangible property and/or intangible property. Examples of tangible property are houses, buildings, vehicles, etc., and intangibles would be something like stock market shares, etc.
‘Basis’ is the amount of the original investment in an asset.
‘Capital Gain’ is the difference between what you sell the asset for and the ‘basis’ (original investment). This is the part the IRS likes to tax you for.
So, for example, if your father purchased a house for $100,000 and then 20 years later sold it for $400,000, the capital gain would be $300,000 (ie $400,000 - $100,000).
Now, if your father leaves you that property upon his passing, ‘stepped-up basis’ comes into play and the law states that the inheritor can use the current market value as the NEW basis (ie stepped-up basis) so that the inheritor does not become liable for the capital gains of the father’s original investment.
Not only do they receive the property itself, the basis or cost value of the property becomes the fair market value at the time of the decedent's death.
This avoids recognizing the gain between the decedent's cost and what it is worth when it is inherited.
In the example above, the person inheriting the property will have a basis of the fair market value at the time of death. The recipient could sell the property for $400,000 and have no taxable gain on the sale.
In the case of inheriting a home, there are two primary methods of determining fair market value; 1) format appraisal, 2) Broker’s opinion of value, most commonly in the form of a Comparative Market Analysis (CMA).
A formal appraisal is the most reliable and defensible estimate of fair market value at the time of the decedent's death. There will be a fee of several hundred dollars for the appraisal.
Another alternative is to get a broker's opinion of value in writing. It may be reasonable to get three opinions to see if they are similar. They should rely on comparable sales surround the inherited property to justify their position.
Either method is acceptable to IRS.
More information on this topic can be found at IRS.gov.